Are You Putting the Right Amount in Your Reserve Fund?
Reserve funds are there to keep associations afloat during lean times, which is why it’s crucial that you have the right amount tucked away. Experts offer tips on determining what that number should be.
Winter is coming. It’s not just a popular Game of Thrones motto; it’s a reminder that bad things could crop up at any moment, so one must be prepared. As the first day of winter approaches, it’s a good time to look at how associations can best prepare for financial downturns. Often, that’s through a reserve fund. But how much does an association need? A recent seminar at Raffa Wealth Management set out to answer that question.
“When it comes to reserves, how much is enough?” asked Raffa’s Chief Investment Officer Mark Murphy, CFA. “Is it six months, 12 months, a percentage of budget? Well, there is no magic number.”
Murphy said determining reserve fund targets is unique to each association, with several items factoring in.
“If something comes up, and you have a lot less in reserves than needed, that could potentially be the end of your organization,” Murphy warned. “On the flip side, if you have way more in reserves than are necessary, there’s an opportunity cost. You could potentially be adding more value for members, not increasing dues as much, or taking on some opportunity that would really strengthen the brand. So, it’s really important to have a good sense of how much you need.”
What Are Reserves For?
Before you determine how much money you need in reserves, you first must decide what you’ll be using it for.
“We’ve worked with organizations that view their reserves as available to satisfy both risk and opportunities—so reinvesting in the organizations,” Murphy said. “Others just want the reserve fund to meet risks. They think that any opportunity should be something that is budgeted for and should never be coming out of the reserve. So, it’s important to understand, ‘What exactly are we doing with the reserves?’”
In addition, Murphy recommends clearly setting out the goal of the reserve fund in an association’s investment policy or reserve policy statement.
Clint Lehman, CPA, who also spoke at the event and is a principal at DeLeon & Stang, added that it is important to understand the makeup of your reserves.
“Are those liquid net assets, or are they tied up in long-term assets or bricks-and-mortar?” he said. “You may have $2 million in unrestricted net assets and think, ‘Wow, we’ve got a great reserve.’ But if it’s all tied up in a building, it’s going to take you a while to turn it around.”
Figuring Out Your Reserve Amount
While each association must come up with its own reserve amount, they typically use a similar process to determine their risks. Murphy said risks to consider include:
- Revenue shortfall. How vulnerable are your revenue streams? Is the money you bring in from conferences, products, or services likely to be down?
- Recession. “Have a sense of what an economic recession could do to your organization and the dollars that might be needed from reserves to fund your organization through that,” Murphy said.
- Membership decline. Use past and current membership trends to calculate likelihood of declines. “We’ve worked with several organizations that have seen a lot of consolidation in their industry, so several large members make up most of their dues,” Murphy said. “If they see additional consolidations, they are going to have to cut back on their budgets, because they’re not going to have the same level of membership.”
- Damaged reputation. An association’s reputation could be damaged by something like a scandal or member data breach. As a result, member recruitment and retention could become difficult and program registration and other sales could decline.
- Leadership changes. The impact of a leader’s departure or death is twofold. First, if your leader was hands on in strategic initiatives, revenue could suffer. Second, there are costs involved in replacing a leader. Murphy said search firms typically charge 35 to 40 percent of the executive’s salary.
- Insurance deductibles. While certain risks can be insured for (such as event cancellation insurance), the policy deductible should be factored into reserves.
Once an organization determines its risks, how likely they are to occur, and the costs involved if they do happen, they’ll have a sense of how much to put in their reserve fund. Raffa has a worksheet [PDF] online designed to help figure out reserve funding.
What risks do you consider when determining your reserve fund target? Share in the comments.
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